The Coming Crash of 2011
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Americans no longer remember the concept of the “business cycle.”
For centuries, market economies have periodically turned down,
and then turned back up. The recovery from such downturns is
natural for a market economy. Every morning, at least some of the
unemployed get up and look for work. Businessmen wake up and
spend the day trying to restore their businesses to prosperity.
As a result, market economies naturally come back to recovery.
This is why the average recession in the U.S. since World War II
has been only 10 months, with the longest, until now, being 16
months.
Bad economic policies can throw economies into downturns,
and delay recoveries. Keynesian economics and rising effective
tax rates produced four worsening inflation/recession cycles in
and around the 1970s: 1969-1970, 1973-1974, 1979-1980, and
1982.
But Reaganomics was so successful that it all but abolished
the business cycle for a generation. The economy took off at the
end of 1982 on a 25-year economic boom interrupted by only two,
short, shallow recessions in 1990-1991 and 2001. That is why
today we no longer recognize the natural workings of the business
cycle.
The current recession was officially scored by the National
Bureau of Economic Research (NBER) as starting in December, 2007.
It was caused by excessively loose Federal Reserve monetary
policy from 2001 to 2006, and the liberal policies creating the
subprime mortgage market, resulting in the catastrophic housing
bubble.
As previously explained in this column, from the beginning
the government tried to address the downturn with long ago
failed, counterproductive, Keynesian economics, rather than
Reagan’s shockingly successful supply-side economics. First there
was the Bush/Pelosi stimulus bill of February, 2008, since
forgotten because it had no positive effects.
A year later, President Obama and Congressional Democrats
came back with the almost $1 trillion stimulus bill, promising
that it would stop unemployment from climbing above 8%. These
bills both involved Keynesian economics because they tried to
stimulate the economy through higher government deficits and
spending. Even the “tax cuts” in those stimulus bills involved
tax credits and rebates that effectively are the same as just
more government spending, sending out government checks, rather
than the tax rate reductions that were the focus of Reaganomics
and supply-side theory, which fundamentally change economic
incentives. The slow and weak recovery from the recession, which
has lasted almost two years (a postwar record), shows yet again
the failure of Keynesian economics, continuing a long, unbroken
record of failure stretching back to the 1930s.
But the Obama Administration came into office knowing that
the economy would ultimately recover as the business cycle turned
up naturally, and planned to reap the political credit, enabling
still greater leaps of neo-socialism. Internally, they are
surprised and miffed that it has taken so long, not understanding
that their own, blindly anti-market policies only delayed
recovery.
The Plague of Left-Wing
Propaganda
A plague of left-wing propagandists from such pustules as
the George Soros-funded Center for American Progress are already
feverishly at work attempting to obscure these economic
realities. On a recent broadcast of the Larry Kudlow
Show on CNBC, Art Laffer politely sat through an infantile
lecture from Michael Linden, Associate Director for Tax and
Budget Policy for the Center, claiming that Laffer had been “long
discredited” in his argument that cuts in capital gains tax rates
produce higher revenues.
But the truth is that over the past 40 years, every
time capital gains tax rates have been cut, revenues have
increased, and every time capital gains tax
rates have been increased, revenues have
declined.
In 1968, a 25% capital gains tax rate generated real
capital gains tax revenues of $40.6 billion calculated in 2000
dollars. The capital gains tax rate was then raised 4 times in
the next 7 years to 35%. By 1975, at the higher rate, capital
gains revenues totaled $19.6 billion in constant 2000 dollars,
less than half as much.
In 1978, the capital gains tax rate of 35% yielded $29.9
billion in 2000 dollars. The rate was then cut 3 times to 20%
over the next 4 years. By 1986, the new rate, 43% lower than the
1978 rate, raised $92.9 billion in 2000 dollars, about three
times as much.
The capital gains rate was raised by 40% the next year, to
28%. Capital gains revenues fell to $56.2 billion that year, and
declined all the way to $34.6 billion by 1991.
In 1997, Congress cut the capital gains tax rate from 28%
back down to 20%. Despite this almost 30% cut in the rate,
capital gains revenues rose from $62 billion in 1996 to $109
billion in 1999. Revenues over the period 1997 to 2000 increased
by 84% over the projections before the tax cut.
Finally, Congress cut the capital gains rate from 20% to
15% in 2003. Capital gains revenues doubled from 2003 to 2005,
despite this 25% cut in the rate. Revenues increased by $133
billion during the years 2003 to 2006 as compared to pre-tax cut
projections.
Other propagandists have compared the unemployment rate in
President Reagan’s second year in office to the rate under
President Obama today. But they fail to account for the fact that
Reagan slashed roaring inflation in half by 1982, and in half
again by 1983. Prices had soared by 25% over the two years 1979
and 1980. But annual inflation fell to 6% by 1982, and to 3% by
1983. Find me the economics textbook that explains how that can
be done without a temporary increase in unemployment. President
Obama, by contrast, is today sowing the seeds for inflation,
rather than conquering it.
Economic Growth in
2010
Just as President Obama’s economic policies are the
opposite of President Reagan’s, his economic performance will be
the opposite as well, as Art Laffer argues in his latest economic
outlook report.
Economic growth will return throughout 2010, due to the
natural economic recovery as discussed above, which this column
predicted a year ago. President Obama often talks as if without
his magic Keynesian fairy dust, the economy would continue to
lose several hundred thousand jobs every month, until the total
number of jobs fell to zero. Thinking people know nothing like
that would ever happen. The reality is that the recovery has come
too little, too late, as also discussed above.
For several reasons, this will be the best year
economically of President Obama’s reign. First, the deeper the
downturn, the stronger the recovery, and this recession has been
the worst since World War II. Given that, real economic growth
this year could be expected to be 6% to 8%. The economy grew by
almost 7% in Reagan’s recovery in 1983 and 1984. But because of
the counterproductive economic policies of President Obama and
his neo-socialist Democrats, growth will only be half that.
Moreover, as Laffer notes in his report, “this slingshot effect
will long be a thing of the past by 2011.”
Secondly, Federal Reserve policy has been enormously
expansive, with the monetary base soaring by 150% over the past
year. Interest rates have also been kept close to zero during
this entire time. Basic textbook economics will tell you that
this boosts the economy in the short term.
Thirdly, the broad tax rate increases scheduled for 2011
will cause producers to produce more in 2010 while they can still
gain the relief of the lower rates. As Laffer writes, “Higher tax
rates on January 1, 2011 will incentivize people to accelerate
income out of 2011 and into 2010.” As a result, “GDP growth in
2010 will be some 3% to 4% higher than it should otherwise
be.”
But I don’t think unemployment will fall this year all the
way to 7%, as Laffer suggests. I don’t think it will fall below
9%.
Down the Roller Coaster in
2011
But, Laffer rightly continues, “when the U.S. economy comes
to 2011, the train’s going to come off the tracks.”
Not only will the slingshot effect of recovery from the
deep recession be over. The positive effect of the enormous Fed
monetary expansion will be petering out. Monetary expansion does
not create long-term economic growth. The Fed has to press the
accelerator faster and faster to maintain the same stimulative
effect. But if it does, then inflation starts to arise,
accelerating faster and faster if the Fed continues. Indeed, the
runaway expansion of the monetary base the Fed has already
engineered will generate explosive inflation if the Fed does not
pull it out in time.
But if the Fed pulls back, interest rates will start to
rise sharply. The borrowing needs of Obama’s record-shattering
deficits will exacerbate this effect, as will the borrowing needs
of a newly growing economy. Those higher interest rates will
squelch the recovery. Or as Laffer says, “Any attempt to rein in
excessive monetary expansion would lead to an immediate and
precipitous economic collapse.”
And we haven’t even begun to talk about the tax rate
increases of 2011. These purely ideological abuses of economic
policy will end up punishing working people nationwide. The top
income tax rate is scheduled to increase by close to 20%, the
capital gains tax rate by at least 33%, and the top dividends tax
rate by 164%. Further tax increases in the pending health care
legislation would raise these tax rates still more. Laffer adds
that starting at the end of 2010,
the U.S. will have a payroll tax rate increase, an estate
tax increase, and income tax increases. There’s also a tax
increase coming in 2010 on carried interest [further
discouraging investment]. This rate will rise from its current
level of 15% to 35%, and then it will rise again in 2011. On
state and local levels, there is also no government spending
restraint and state tax rates are rising.
Also pending is an $800 billion cap and trade tax on
energy, and high cost, unreliable energy is another prescription
for economic failure.
“The rich” don’t even have to pay these higher taxes for
the higher rates to have a devastating effect on working people.
Working people will suffer if investors just respond to the
resulting incentives by pulling back their money, or sending it
overseas for investment in friendlier economic climates, like
India, Brazil, and China. That will result in fewer jobs, lower
wages, higher unemployment, and slower economic growth or even
decline in America.
Laffer explains just how devastating the resulting reversal
from the artificially pumped up economy of 2010 can be,
saying,
The tax boundary that will occur on January 1, 2011 tells
me that GDP growth in 2010 will be some 6% to 8% higher than
GDP growth in 2011. A year on year decline from trend of some
6% to 8% in GDP growth would represent a larger collapse than
occurred in 2008 and early 2009.
Again, just the opposite of the long-term economic boom
that followed the 1982 downturn when Reagan first slayed
inflation, the flowering of growth in Obama’s second year will be
followed by long-term stagnation and economic decline for
America, slaying the American Dream, until President Obama’s
neo-socialist economic policies are reversed.
The only hope for change the American people have now is to
engineer a dramatic change in leadership in Washington in this
year’s elections. Only that can restore the prosperity policies
necessary to avert the Coming Crash of 2011.
